Assets Turnover and Net Operating Assets - Case Study Example

Prospective analysis Student name Name of institution Prospective Analysis Revenue The revenue is the sum of casino, hotel, convention centre, food and beverage, tower admissions and other revenues. The growth rate is estimated to be 8 percent in 2015. This projected increase in sales is attributed to the company’s strategy to diversify its operations. The company will add 470 gaming machines and tables in Auckland casino following by signing a building contract for the international convention Centre in October (Radio New Zealand News 2015) and this is expected to increase revenue drastically. In 2016, the revenue growth for 2016 is estimated to be 6.5 percent. The company’s growth rate has been fluctuating in the last five years (2010-2014), and it can be attributed to fluctuations in demand and competition. From 2017 to 2019, the revenue growth rate is estimated to be constant at 5 percent. Assets Turnover (ATO) and Net Operating Assets (NOA) The ATO is projected to be 1.11. This is the average for the last five years (2010 – 2014). This low assets turnover is attributed to the company’s differentiated strategy, and therefore for the same reason, the trend is expected to continue in the next five years. With the progressive increase in sales in subsequent years, the company is set to record increasing Net Operating Assets. In 2015, the Net operating Assets is estimated to be $79,813,000 (See Appendix). Profit Margin The profit Margin for SKYCITY is forecast to be18.33 percent. This is an average of the profit margins for the last five years ended June 2014. This relatively high profit margin is attributed to the company’s product and service differentiated strategy and a strong focus on cost management as respectively according to the company’s annual reports. Hence, the company is expected to record increasing Net Operating Profit After Tax in the subsequent years. In 2015, the company’s NOPAT is forecast to be $132,171,000 and $162,408,000 in 2016(NOPAT =Sales*PM). Free Cash Flow Free Cash Flow is the left money when a company clearly paid off all expenses and investment and this ratio can be used to assess an economic capacity of the company. Free cash flow is obtained by subtracting the change in Net Operating Assets (NOA) from Net Operating Profit After Tax (NOPAT). In 2015, the Net Operating Assets are estimated to change by $2,039,000 and the Free Cash Flow is projected to be $160,369,000 that is ($162,408,000-$2,039,000=160,369,000). In 2016, the Free Cash Flow is expected to decrease to $121,039.this might put the company’s dividend at risk since it will require more free cash flow to pay the dividends after paying additional expenses for the expansionary strategies. It company might also not be able to pursue new opportunities when they arise or develop a new product or service. See appendix 1 for more information. Net Dividend Payout The dividend payout ratio is estimated to be 74.73 percent. (Dividend paid=NOPAT*dividend payout ratio). This payout ratio is estimated to be consistent in the next five years. In 2015, the dividend paid will be $121,369 i.e. (162408*74.43%). The net dividend payout ratio is expected to increase to $129,258, $135720, $142,506 and $149,632 in 2016, 2017, 2018 and 2019 respectively. This prospective high growth in dividends is likely to attract more investors to buy more stock of the company as it portrays good and sustainable financial performance. Cost of debt The cost of debt is estimated to be 9.76 percent in the next five years, which is an average of the costs of debt for the last five years, starting from June 2010 to June 2014.The debt balance is estimated to reduce from 22928 in 2014 to 13835.55 and 6967.15 in 2015 and 2016 respectively. This means that the operations of the company will be basically financed by shareholders equity and thus the company will have liquidity to be able to meet its obligations as and when they fall due. Sensitivity Analysis Using the CAPEM analysis (see appendix), the market price of a SKYCITY share was $3.69, the number of outstanding shares was 580,760 and the number of shares traded on ASX was 123,600. Compared with the company’s stock valuation using the Dividend Discount Model, the price of a share is estimated to be $3.66 as illustrated below: Dividend Discount model Actual 2014 2015 2016 2017 2018 2019 1 2 3 4 5 Forecast net Dividend payout 121,369 129,258 135,720 142,506 149,632 Estimate cost of capital for equity 10.55% 1.11 1.22 1.35 1.49 1.65 Forecast dividend growth patterns 6.5% 5.00% 5.00% 5.00% Calculate TV (div from next year )/cost of capital growth 2,698,500 Discounted dividend stream to TV (2016) 316,033 109,791 105,774 100,468 95,4291, Discount TV 1,807,032 1,807,032 Total value 2,123,065 Number of shares outstanding 580,760 Share price $3.66 The Discounted Cash Flow model values the company’s share at $3.79.This is higher than the market value of share which is $3.69 Discounted Cash Flow Actual Forecast 2014 2015 2016 2017 2018 2019 Forecast FCF 160,368.95 121,039.42 139,074.18 146,027.89 153,329.28 Book value of debt 22,928 Estimated cost of capital for the firm 10.48% 1.1048 1.2206 1.3485 1.4899 1.6460 Forecast FCF growth pattern -25% 15% 5% 5% Calculated TV 2,797,464 Discounted FCF to TV year 347,448 145,155 99,163 103,130 98,013.36 Discount TV 1,877,647 1,877,647.42 Total value 2,225,096 Value of debt 22,928.00 Total value of equity 2,202,168 Number of shares outstanding 580,760 Value per share $3.79 The valuation of the company’s shares using the Discounted Abnormal Earnings gives an estimated share price of $3.90, which is above the market valuation. The discounted abnormal operating earnings model values thee company’s share at $3.96 while These stock valuation models give a higher value of the company’s share than the book value, implying that the company is performing higher than analysts’ expectations. This is an indication that the management of the company is making investment decisions based on good expertise aimed at achieving better company performance and hence adding value for the company. 1. Application Potential opportunities 1. Growth potential-going global Skycity has a high potential for growth and expansion, attributed to the high growth rate of the company. The company operates in the gaming and entertainment industry as well as hotel, hospitality and entertainment industries. This diversified portfolio of revenue generating activities has placed the company in a better position to increase its revenue generations. The countries in which the company operates also have high GDP’s, increasing the potential for the company to increase its sales and revenue. The projected revenue growth rate of 8% and 6.5% for 2015 and 2016 indicates good financial performance of the company. Hence the company can take advantage of this to expand its products and reach new international markets. 2. Good management Good management expertise and value addition for the company is portrayed in the performance of the company stock which is high above analyst expectations. This is an opportunity that makes the company stock attractive to potential investors due to the lucrative performance. Shareholder wealth maximization is also achieved, increasing shareholder confidence in the management and the company as a whole. The company should therefore focus on training potential managers so that the company’s good performance as projected in the analysis can be realized in the future. Potential challenges 1. Threats from existing companies The company faces competition from its main competitors which are Crown Limited and TABCORP Holdings Limited. The three companies are exerting monopolistic pressures in the casino industry in Australia and New Zealand, although there are other smaller upcoming new entrants in the industry. These competitive forces are a challenge to SKYCITY and it has to counter them so as to have a competitive edge in the industry and maintain its revenue generation. 2. High customer bargaining power. According to Entrepreneurial Insights (2014), customers have a high bargaining power in the casino and gaming industry. Therefore, bargaining power of customers is strong and powerful in gambling market. When they have strong power to influence a company’s product and selling decisions, they can demand a high quality in term of services provided or products. 3. High dividend payout. Although a high dividend payout ratio indicates good financial performance, it can have adverse effects in the company. SKYCITY has a projected dividend payout ratio of 74.73 percent. This can lead to the company being left with little fee cash flow to finance growth, development of new products and take advantage of new opportunities. 4. Strategy execution risk SKYCITY Entertainment’s Auckland and Adelaide expansion plans put the company at material risk. These potential risks include cost overruns, construction delays, and massive capital requirement of the two projects. This will lead to little free cash flow available for paying dividends, hence putting dividends at risk. 5. Regulatory risk SKYCITY Entertainment faces regulatory risk caused by the unforeseen changes in the Government’s attitude toward licenserenewal issues. Failure by the company to meet certain regulatory requirements might negatively affect the negotiated terms with the New Zealand Government in the construction contract, and the company might lose the renewal rights for its license to operate in Auckland. Remedies and recommendations 1. To counter competition and achieve core competence in the casino and gaming industry, SKYCITY needs to diversify its operations and services. In addition, the company needs to explore new markets internationally ton increase its market share, sales revenue and profitability in general. It can target countries in other continents such as Africa, which are tourist destinations and have high demand for quality services in the hotel and hospitality industries. 2. Since customers in the casino and gaming industry have a high bargaining power and demand quality services, SKYCITY should work on a strategy to improve customer service as well as offer a variety of services. 3. SKYCITY needs to adopt a moderate dividend policy, that will ensure that satisfactory dividend is paid to shareholders, and at same time the company has sufficient free cash flow to enable it carry out growth projects and take advantage of new opportunities when they arise. 4. SKYCITY should reduce its underperformance risk by not putting large capital investment in same place, but diversify operations as well as explore new markets. The company should also negotiate better license renewal terms with the respective governments to avoid the termination of its operations. References SkyCity Entertainment Group 2013, ‘2013 Annual Year Results Presentation’, SkyCity Entertainment Group, viewed 31 August 2015, < http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MTk4MzIxfENoaWxkSUQ9LTF8VHlwZT0z&t=1>. SkyCity Entertainment Group 2014, ‘2014 Annual Report’, SkyCity Entertainment Group, viewed 30 August 2015, . Radio NewZealand News 2015, ‘Sky City: New gaming machines needed to meet demand’, Radio NewZealand News, viewed 14 August 2015, . APPENDIX 1 - Reformation APPENDIX 2-Table of Forecasting APPENDIX 3 Tables of Calculation of Valuation models APPENDIX 4- RATIOS APPENDIX 5 – SENSITIVITY TESTING Read More